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a case study of the implementation of the EU eigth directive in Denmark 1984-2003

Loft, Anne; Jeppesen, Kim K.(København, 2003)

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Abstract:

This paper analyses the complex process through which EU's Eighth Company Law Directive on the qualification of statutory auditors (1984) was implemented in Denmark. The Directive envisaged one group of ‘statutory auditors’ in each member state. However, in Denmark there were two groups of auditors: the state authorised auditors who had a long education and high status, and the registered auditors who had a shorter education, lower status and whose clients were mainly medium and small sized businesses. An exemption was made in the Directive to allow the registered auditors to continue to audit despite that they did not have the required ‘university level’ education. This made the issue of education central to the long-term survival of the registered auditors and it consequently became the object of a long conflict between the parties with an interest in auditor education and qualifications: the profession, the state and the educational institutions.
This case illustrates the processes of audit regulation in a small European state with a highly developed economy where auditors are approved and regulated by the state but through processes heavily influenced by the profession. It provides an interesting contrast to other studies carried out on the implementation of this Directive, e.g. in the UK (Cooper et al, 1996) and in Greece (Caramanis, 1999), and perhaps some insight into the difficulties which may be encountered in implementing the new Eighth Directive proposed by the Commission in May 2003.
Key Words:
EU; Eighth Directive; accounting profession; Denmark; harmonisation; regulation.

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Adopting a survey approach, our study examines how firms implement impairment test of goodwill. We focus on how firms define and measure the recoverable amount of CGU. The survey includes 58 completed questionnaires representing 73% of the firms on the Copenhagen Stock Exchange that recognise goodwill in the balance sheet. Our survey generally supports that a common practice on impairment tests of goodwill has not yet been established. Based on our analysis it is difficult to determine whether this simply reflects that firms adopt an approach suited to their organisational and economic structures or if it exposes that firms are uncertain as how to apply a standard. The analysis also reveals that some of the methods used when defining a CGU are not in compliance with IAS 36. In addition, we find inconsistencies in the way that firms estimate the recoverable amount. Our analysis should be of interest to a number of parties including firms, financial advisors, auditors, standard setters and users of financial statements. Impairment tests, IAS 36, compliance, goodwill, value in use, valuation techniques.

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Fair value accounting has become predominant in accounting as a vast number of IAS/IFRS standards are based on fair value accounting, including IAS 36 Impairment of assets. Fair value accounting for goodwill is technically challenging, since market prices are not observable. Thus, valuation technologies must be applied in order to test goodwill for impairment.
While prior research on goodwill has concentrated on either the (dis)advantages for each accounting procedure for goodwill or examined the value relevance of goodwill (amortization) and goodwill write-offs, little effort has been devoted to the technical problems in the implementation of IAS 36. However, recent research on the topic document that firms commit a variety of errors in applying IAS 36 (Petersen and Plenborg, 2007).
We examine firm characteristics that might explain the frequency of errors that firms commit in applying impairment tests. Our findings suggest that at least two factors might explain why errors are present – the lack of an impairment manual and not involving employees with rigorous experience in firm valuation.
Our research, which might be seen as the fist step toward guidelines in applying technically challenging accounting standards, should be of interest to firms, auditors and standard setters.

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This study focuses on methodological errors that arise when firm valuation is carried out in practice. Violation of assumptions underlying the valuation models are examples of methodological errors. We analyze valuation spreadsheets from five Danish financial institutions (i.e., stockbrokers and corporate finance departments) in order to trace if firm valuation models are properly applied. We conclude the following: (i) Methodological errors often cause valuation models to generate estimates that differ significantly from the theoretically correct value; and (ii) Firm value estimates were biased due to a variety of methodological errors. The implications of those errors may be significant. Investors are exposed to poor recommendations. Financial institutions such as investment bankers and stockbrokers may be exposed to bad reputation and lawsuits. Accounting firms that do not carry out firm valuation correctly (for example in testing goodwill for impairment) also run the risk of litigations.

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’Growth’ as a concept is often not very well understood. Growth may be measured in a variety of ways (e.g., growth in turnover, earnings, earnings per share, assets, and shareholders equity).
Investors and other capital providers generally find it attractive to invest in ‘growth firms.’ For instance, earnings per share (EPS) figures are widely published and used by investors. An increase in EPS is seen as a signal of improved profitability. Likewise, growth in earnings measures such as EBIT, EBITA, EBITDA etc. seem to indicate that firms are value creating.
Our paper discusses if and under what conditions growth in accounting variables (accounting numbers and financial ratios) is value creating. We find that growth in one-periodic earnings measures does not necessarily create wealth for shareholders. Only growth in economic income is value creating. Our analysis also provide evidence that users of accounting information should be aware of the quality of growth and distinguish between growth based on transitory vs. permanent components of earnings. Our analysis finally documents that growth in earnings per share or return on equity caused by share repurchases has no economic significance.

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When an enterprise is divided into smaller organizational units, each with its own results accountability, the question arises how to manage and measure the efficiency and profitability of such units. A task which is complicated when organizational units in the same enterprise or enterprise group trade internally as the units have to decide what prices should be paid for such inter-unit transfers. One important challenge is to uncover the consequences that different transfer prices have on the willingness in the organizational units to coordinate activities and trade internally. At the same time the determination of transfer price will affect the size of the profit or loss in the organizational units and thus have an impact on the evaluation of managers‟ performance. In some instances the determination of transfer prices may lead to a disagreement between coordination of the organizational units and overall profitability of the enterprise on the one hand and measurement of profitability and managers‟ performance in the units on the other. This chapter addresses these issues.

This paper examines if the level of voluntary disclosure affects the association between current returns and future earnings. Economic theory suggests that firms might find it advantageous to provide additional pieces of information (i.e., voluntary disclosure) to investors and analysts (Verrecchia 1983). Our results indicate that more voluntary disclosure does not improve the association between current returns and future earnings; i.e. current returns do not reflect more future earnings news. This finding raises the question whether voluntary information in the annual report contains value relevant information about future earnings or if investors are simply not capable of incorporating voluntary information in the firm value estimates.
Key words: Disclosure, future earnings, informativeness